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Managing the Bailout: He’d Do It for Nothing

NEWPORT BEACH, Calif. — One of the chief concerns about the Treasury Department’s $700 billion bailout plan is that the same Wall Street firms that helped create the crisis could make a killing cleaning it up.

William H. Gross, the manager of the country’s largest bond mutual fund, has a solution: he is offering to sort through the toxic assets — free.

“We have a large and brilliant staff that can analyze and has analyzed subprime mortgages that can help the Treasury out,” Mr. Gross, the co-chief investment officer for the Pacific Investment Management Company, said in an interview at the company’s headquarters here.

He added, “And I’d even be willing to say that if the Treasury wanted to use our help, it would come, you know, free and clear.”

Mr. Gross explained his offer as a philanthropic one. With Pimco’s $830 billion under management, “we make fees aplenty,” he said. That could be considered an understatement. Pimco is a behemoth in credit markets, and Mr. Gross talks about them with a confidence that reflects his ability to maneuver in them.

“Today’s the worst day yet and nobody knows it,” he said. “Everybody is squirreling away cash. Even the big banks are refusing to lend money.”

Bid-ask spreads on bonds in almost every sector of the debt markets stretched to a full point or more. “It’s not a pretty situation today, much worse than last week,” Mr. Gross said.

“Those who just look at the stock market wouldn’t know it,” he added, because the Dow Jones industrial average was down only 126 points at the time. “But the credit markets are doing a pretty good job of freezing up.”

Despite his proposal to offer his talents, gratis, some investment managers say the government should be wary of giving authority for the auction of mortgage securities to anyone in the private sector, particularly someone with as dominant a position in the bond market as Mr. Gross.

Luis Maizel, a senior managing director of LM Capital Group in San Diego, said the government should instead turn to someone like a former official of the Federal Home Loan Bank Board, which is now defunct, or the Federal Reserve.

“They should start with somebody who doesn’t have a conflict,” Mr. Maizel said. “Bill Gross is a good friend of mine, but if you put this in Bill’s hands, Pimco is going to come out great and I don’t know that the government will.”

Mr. Gross says that all he wants in return for helping the Treasury Department is for Pimco “to be recognized for the way we’ve seen this crisis coming, and for the way we’ve talked about what’s required.”

For more than a year, Mr. Gross, whose investment expertise has earned him a net worth estimated at more than $1 billion, according to Forbes, has indeed played the role of the financial markets’ Cassandra. Beginning in July 2007, he warned that the subprime mortgage crisis would become far worse before it would improve.

Other sectors of the financial markets, he predicted, also could seize up if the Federal Reserve and the Treasury did not do something to help keep the markets liquid.

But Mr. Gross and Pimco also attracted criticism when it became clear that the Pimco Total Return fund earned more than $1.7 billion on the day the federal government bailed out Fannie Mae and Freddie Mac.

Mr. Gross had been advocating such a move for more than a year, at the same time that he was moving more than 60 percent of his fund’s assets into government-agency bonds. The shift in investment strategy began in earnest shortly after Pimco hired Alan Greenspan, the former Federal Reserve chairman, as an adviser last year.

Mr. Gross said there was nothing wrong with that advocacy because Pimco had no official role in formulating the plan to rescue Fannie Mae and Freddie Mac.

“We had a role on CNBC,” he said, “in that every time we were asked, or I guess every time that The New York Times would call, they would say, ‘What are you doing?’ and we would say: ‘Well, we want safe, agency-guaranteed mortgages. We don’t want to take a lot of risks in subprime space.’ ”

Photo

William H. Gross, manager of Pimco, offered Treasury pro bono management of the assets of the bailout fund.
Credit
J. Emilio Flores for The New York Times

With the current liquidity crisis touching virtually every sector, any firm in a position to advise the Treasury on its rescue plan would have potential conflicts of interest, Mr. Gross said. “There’s fewer of them here than anywhere else,” he added. “Simply because we saw the crisis coming and we don’t have much of this paper.”

The calm of the Pimco trading floor is perhaps a reflection of that reality. Even in the midst of the Wall Street tumult, it is less cacophonous pit than library, the low murmur of conversation among portfolio managers drowned out only by the clacking keyboards.

Mr. Gross, a lanky 64-year-old who practices yoga and sometimes speaks so softly that colleagues lean toward him, drifted around the room on Tuesday, an unknotted pale blue Hermès tie draped around his neck, his gray and brown hair extending down over his ears, reminiscent more of the 1970s than today.

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Pimco’s headquarters sit on a bluff overlooking the Pacific Ocean. On a clear day, the view extends westward beyond Catalina Island, which sparkles like a jewel in the midday sun.

The windows on the Pimco trading floor, where Mr. Gross spends most of his time, however, face in the opposite direction — toward Wall Street and Washington, two arenas where Mr. Gross and his firm carry outsize influence.

Mr. Gross, who talks regularly with Mr. Paulson, believes the bailout plan should grant broader relief for homeowners and others weighed down by unmanageable debt. He says foreign banks should be allowed to take part in the program, but he argues against any measures that would try to restrict executive compensation — a move that Mr. Paulson tentatively backed Wednesday.

“I don’t even know if it’s legal,” Mr. Gross said of attempts to limit executive pay. “And so I think that complicates the situation. That’s not to defend those that are making big checks, but I don’t think it should be attached to this.”

Mr. Gross is also skeptical of proposals to have the Treasury take ownership stakes in banks that sell troubled assets to the government.

Buying a pool of subprime mortgages is not like buying part of a company, he said. The Treasury would own something — the mortgages themselves, which, if it pays the right amount for those loans, could earn it a yearly return of 12 to 13 percent when they are resolved.

“All the capital gains will accrue to the Treasury,” he said. “There’s tons of equity here. It’s just that it’s very difficult for American taxpayers to understand.”

The key, of course, is price, which is where an adviser to the Treasury would come in. Mr. Gross says much of the opposition to the plan stems from a misunderstanding that the Treasury would buy troubled mortgage bonds at face value.

On the contrary, Mr. Gross said, he would advise the Treasury to pay closer to 60 or 65 cents on the dollar for the mortgage bonds.

“If the price is right, the Treasury’s going to make money,” Mr. Gross said. “They made money on Chrysler. They can make money on this,” he said, referring to the federal bailout of the carmaker in 1979 and 1980.

Still, when asked how he saw the broader economy here and abroad over the next year, Mr. Gross responded simply, “Not pretty.”

“There will definitely be a prolonged period of either slow growth or recession for 12 to 18 to 24 months,” he said. “We’re not going to get out of this easily or scot-free. It’s just gone too far to now turn around quickly and to move into a positive growth mode.”

In the meantime, a surge in regulation of the financial sector will be unleashed, probably an inevitable result of the problems and rescues of recent months.

“Twelve to 24 months down the road, all of these high-flying investment banks and banks will be reregulated and downsized,” Mr. Gross said. “They won’t become arms of the government, but they will be supervised and held on a tight leash.”

The greater regulation should draw investors back to the market and away from what seems to be their current financial strategy — stuffing their cash in mattresses.

Even Mr. Gross admits that he has been, at times, reluctant to commit.

“We were offered this morning a six-month sizable piece of Morgan Stanley,” he said on Tuesday. “Here’s the surviving investment bank that just last night got equitized or bailed out by a Japanese bank. We were offered a sizable piece of a six-month Morgan Stanley obligation at a yield of 25 percent, O.K.?”

Pimco did not buy the bonds, “because we thought we could get it even cheaper,” Mr. Gross said, adding that thinking of that kind was at the heart of today’s market paralysis.

“That’s where the fear builds in and makes for totally illiquid markets,” he said. “Where no one trusts anybody; no one trusts any price.”